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by the stockholder as a dividend. The same amount may also be deducted as a tax of the stockholder paid for him by the corporation as his agent. The net result of reporting such amount as a dividend, and claiming the same amount as deduction, is that the amount of tax is offset against the stockholder's income from other sources in assessing the normal tax.22

Stock Dividends. The 1916 Law expressly provides that stock dividends shall be taxable. It defines a stock dividend as a distribution by a corporation out of its earnings or profits accrued since March 1st, 1913, and payable to its shareholders in stock of the corporation. It also provides that such stock dividends shall be considered income, to the amount of the earnings or the profits so distributed.23 A stock dividend is only taxable where a cash dividend would be taxable. Any distribution made in the form of a stock dividend, which would not be taxable if made in the form of a cash dividend, is not made taxable by reason of the distribution being made in stock.

RULE UNDER 1913 Law. The 1913 Law was silent as to stock dividends, and it was at first held by the Treasury Department that such dividends were not subject to tax, on the theory that the additional shares of stock issued to the stockholder represented no more than the same interest in the identical property represented by his stock before the dividend. The Treasury Department subsequently changed its attitude and held stock dividends to be the equivalent of cash and to constitute taxable income under the same conditions as cash dividends.24 Only one case has been decided under the 1913 Law, and in that case the District Court held a stock dividend to be taxable.25 The court said in part:

22 For a further discussion of this subject see Chapter 30 on Deduction of Taxes.

23 Act of September 8, 1916, § 31, added by Act of October 3, 1917. The 1916 Law prior to the amendment contained substantially the same definition of stock dividends.

“I can give little weight to the argument that the issue of a stock dividend did not affect the market value of the plaintiff's aggregate holdings and that the distribution of 50% more stock to the stockholders lessened the market price of their original stock 3313%. This would be true in case of any cash dividend extraordinary, or even ordinary. The cash distributed, plus the market value of the stock after the dividend was paid, would ordinarily be equivalent in value to the stock before the dividend. But the objection seems impressive that the transaction in nowise affected what the stockholder already had except to give him additional pieces of paper evidencing his ownership. He does, however, have something different before and after receiving the additional stock. What was before a mere chance that he might receive his share of the surplus in cash dividends, and a vague right to secure them if the directors withheld them in a way and to an extent that indicated bad faith, is now converted into a permanent interest in the capitalized surplus. He has lost the chance of cash dividends and gained an interest in the corporate enterprise that cannot be taken away. This interest

24 T. D. 2274, dated December 22, 1915.

25 Towne v. Eisner, U. S. D. C. S. D. N. Y. 242 Fed. 702. In this case it was also held that the dividends were subject to tax although declared from surplus, all of which was earned prior to January 1, 1913, and paid January 2, 1914. The case is now before the Supreme Court on appeal.

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is derived from earnings and may be really of much greater advantage to the stockholder than the possibility or right which he has lost. It becomes capital of the corporation, but in his hands it is income and in many respects resembles the common extraordinary cash dividend accompanied by a right to subscribe for additional stock at par to an amount equivalent to the dividend in cash. To say that this distribution is not income because he received no cash and the intermediate step is not taken is, to my mind, quite to dis regard the real nature of the transaction. “The real stumbling block which affects everyone

is the taxation of very large accumulations of earnings distributed by corporations after the passage of the Act. Certainly the mere matter of size can make no difference in determining whether the property taxed is income or not. The doubt I have felt in reaching my conclusion has not been due to the nature of stock dividends, but to the difficulty

in determining whether Congress intended to tax earnings at all which had accrued in the hands of the corporation prior to the passage of the Act, but were distributed later." The 1916 Law “providing that a cash or stock dividend payable out of earnings since March 1, 1913, shall be considered income has no bearing upon this case. It may be argued that it was a limitation or an extension of the income taxable by the Act under consideration, but in neither event can it be held to define the income which was theretofore taxable." 26

26 As a practical matter it seems absolutely necessary that the law should tax stock dividends, otherwise the supertaxes could be avoided by individuals forming corporations to hold their personal estates and reinvesting the earnings from year to year, the yearly surplus in each case being converted into capital by a distribution of stock dividends.

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MONEY VALUE OF STOCK DIVIDEND. The present law provides that a stock dividend shall be considered income "to the amount of the earnings or profits so distributed." Prior to the amendment, the 1916 Law provided that a stock dividend should be taxable to the amount of its cash value." Both phrases are construed to have the same meaning. The value of each share of the stock dividend, for the purpose of the income tax, is determined by dividing the amount of earnings, profit, or surplus distributed, by the total number of shares constituting the stock dividend. In other words, the amount which the stockholder would have received had payment been made in cash, is the amount to be reported as income.27 The par value of a stock dividend usually indicates the amount to be reported as income. The fact that the stock dividend may have a market value, at the time it is received by the stockholder, greater or less than its proportionate value as a part of the surplus of profits distributed, does not alter the rule. In a subsequent sale of the dividend stock, the value at which it was reported as income when received as a dividend is to be considered as its cost, and the profit or loss realized from the sale should be figured accordingly, as in the case of any other sale of property.28

27 Letter from Treasury Department dated October 30, 1916; I. T. S. 1917, 1164.

28 Letter from Treasury Department dated March 24, 1916; I. T. S. 1917, 1 166.

CHAPTER 24

INCOME FROM ROYALTIES

The Treasury Department expressly requires that royalties from mines, oil wells, patents, franchises, or other legalized privileges shall be separately reported by the individual, but not by corporations. No particular rules have been issued with respect to royalties and with respect to income from royalties, except to hold that where royalty is received in exchange for a right to manufacture and sell an article under a patent, the amount of the royalty received is income. In the case of mines operated by a lessee on a royalty basis, the amount of royalty received by the lessor is income.?

Royalties from Mines. In has been contended that royalties received under mining leases and oil leases are in fact not income but payments of instalments on the purchase price of the natural deposit. The nature of such leases has been the subject of some difference of opinion in the courts. It has been held that the leases are such in name only, and are in fact conveyances of the ore body in place as a part of the realty, and that the so-called royalties merely represented payments for so much land and were in no just sense income, but mere

1 Letter from Treasury Department dated January 24, 1916; I. T. S. 1917, 11187. 2 T. D. 2152.

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